China in the News - Money, Trade, and Housing

In the last few days there has been a lot of news about China - the makeup of currency reserves, increasing trade imbalances, rumored gold purchases, changing exchange rates, uncertain interest rates, and falling home prices.

These were just some of the topics. If you didn't know any better, you might think there were problems brewing.

Here are a few highlights.

Last week, the big news from China was that they are beginning to lose interest in the current trade arrangement where they exchange manufactured goods for little slips of paper from the United States. Even though storing dollars and dollar denominated assets in electronic form is convenient, apparently it is not very satisfying.

China Set To Reduce Exposure to Dollar

China has resolved to shift some of its foreign exchange reserves -- now in excess of $800 billion -- away from the U.S. dollar and into other world currencies in a move likely to push down the value of the greenback, a high-level state economist who advises the nation's economic policymakers said in an interview Monday.
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In recent years, the value of the dollar has been buoyed by major purchases of U.S. Treasury bills by Japan, China and oil-exporting countries -- a flow of capital that has kept interests rates relatively low in the United States and allowed Americans to keep spending even as debts mount. Some economists have long warned that if foreigners lose their appetite for American debt, the dollar would fall, interest rates would rise and the housing boom could burst, sending real estate prices lower.

The comments of the Chinese senior economist, made on the condition of anonymity because the government disciplines those who speak to the press without express authorization, confirmed an analysis in Monday's Shanghai Securities News stating that China is inclined to shift some its savings into other currencies such as the euro and the yen, or into major purchases of commodities such as oil for a long-discussed strategic energy reserve.

But, then they said that wasn't true. In a follow-up to the original report, it is learned that they do not intend to get rid of any dollars they currently hold. This likely calmed many nerves, but note that there is no mention of adding to dollar reserves with the dollars they will accumulate in the future.

China Unlikely to Sell Dollar Reserves

China is unlikely to sell current U.S. dollar assets in its foreign reserves to diversify its holdings, the chief of research at the central bank said on Tuesday, contradicting market speculation.
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"The general trend is that every country wants to diversify its reserves," Tang said on the sidelines of a conference. "No one is willing to put all of their eggs in one basket and it is impossible for China to put all its forex reserves, which exceed $800 billion, in one currency. But it is unlikely that China would reduce its current dollar assets to increase the proportion of other assets," he said.

Dollar assets still dominated the reserves, whose mix was based on the currencies that denominated China's exports and imports.

On Thursday, China's State Administration of Foreign Exchange issued a statement on its priorities for 2006 and said it would "improve the operation and management of foreign exchange reserves and actively explore more effective ways to utilise reserve assets."

The current trade imbalance with the U.S. requires that that they do something with the $200 billion U.S. dollars that will come their way in 2006. What will it be? It sounds like they favor commodities.

China's Central Bank Denies Dollar Plans

Financial analysts say China has few options to move assets out of dollars due to the vast size of its reserves, because financial markets in other currencies offer fewer choices of bonds and other assets that can be readily bought and sold.

Gold prices have risen to 25-year highs on speculation that China, as well as other nation's central banks, might shift reserves into precious metals. Gold closed at US$546.50 an ounce on Tuesday in Hong Kong, up US$4.50 an ounce from Monday's close. That's the highest since March 1981.
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Chinese officials and academics have debated whether Beijing should use its foreign currency to buy oil fields or build up a petroleum reserve to insulate itself from price shocks.

Chinese state-owned oil companies have been on a campaign in recent years to secure foreign supplies of oil and gas, financed in part by low-priced government credit.

The Chinese are likely growing increasingly disappointed with what they are told they can't or shouldn't buy with their U.S. dollars. First they are told they can't buy Unocal, an American oil company, now someone at the Dow Jones is saying they can't buy gold because the price will skyrocket.

Gold Market Too Small For Chinese Diversification

The world gold market is too small for China to achieve any meaningful diversification into the precious metal, leaving it likely the country will instead follow a more cautious, dollar-bound investment path, analysts said Monday.

Sentiment towards gold has been boosted since Friday, when it was reported that China may start to diversify its foreign exchange reserves away from the U.S. dollar and government bonds.
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"We view China's ability to raise gold holdings to a meaningful level for diversification as constrained, as the gold market is too small for this to happen without a serious price distortion," said Barclays Capital analyst Yingxi Yu.
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"The bulls in the market would argue that at a sharply higher gold price - an inevitability if China and/or Japan did begin to buy gold on the open market - the volumes required would be commensurately lower. Nevertheless, liquidity remains a key consideration," Williamson said, adding that his statistics are based on a gold price of $528/oz.
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Also, it's still uncertain whether or not increased volumes of gold changing hands at the gold fix in recent weeks are anything to do with Asian central banks buying gold.

"We have no way of knowing if this is true," said UBS analyst John Reade. "We have no evidence that central banks in the region are adding to gold reserves, but we noted a lot more interest in the metal than we have seen in recent years," Reade added.

It seems that on this side of the Pacific Ocean, there is an expectation that the current imbalances can and should continue just as they are, indefinitely. Our Asian trading partners should just be happy with the current arrangement.

The U.S. is dependent on inexpensive goods from Asia, but these low prices mean more lost jobs here. If currencies adjust to their natural levels, prices would naturally rise, creating inflationary pressures, and that would be a bad thing. This is one of the secrets to our supposed "non-inflationary growth" - cheap imported goods from Asia offsetting the rising costs of energy and services here in the U.S., but there is some discontent in Congress over this relationship.

China Cautioned Over Trade Gap

China's currency exchange controls and trade surplus are fanning so much ire in Washington that Congress may pass legislation threatening to punish Beijing, a U.S. senator said Tuesday.

Max Baucus, the top-ranking Democrat on the Senate Finance Committee which oversees trade policy, said he favors trade with China and opposes legislation targeting China's currency exchange rules. But the ballooning U.S. trade deficit with China may encourage many lawmakers to support such steps, he said.
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The U.S. trade deficit with China probably topped $200 billion in 2005 -- a 25 percent increase on the previous year and nearly 30 percent of the total U.S. deficit, Baucus said.

What does all this mean for the dollar? Martin Feldstein explains that one way or another, despite assurances via capital flows that foreigners are happy to reinvest their U.S. dollars back in the states, this is a misleading indicator - the dollar must adjust.

Why Uncle Sam's bonanza might not be all that it seems (PDF)

A major reason for the dollar’s current overvaluation is the widespread misunderstanding of the nature of capital flows to the US. The business press and many financial analysts provide the reassuring message that the flow of capital to the US substantially exceeds the amount needed to finance the US current account deficit, and that that inflow is coming primarily from private investors who are attracted by the strength of the American economy.

This optimistic analysis of the capital inflow is wrong. It results from a misinterpretation of the data provided by the US Treasury.
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My own belief, based on widespread conversations with officials and with private bankers, is that the inflow of capital that now finances the US current account deficit is coming primarily, perhaps overwhelmingly, from governments and from institutions acting on behalf of those governments.
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Experts estimate that the real trade-weighted value of the dollar must fall by at least 30 per cent just to shrink the trade deficit to a more sustainable level of 3 per cent of GDP. Much larger dollar declines are also possible.

Lenders in the U.S. are naturally concerned about what all this means to interest rates. It is unlikely that the housing boom can achieve a soft landing with rising long term rates.

U.S. Mortgage Watchers Worry about China FX Move

China's recent signal that it may diversify its foreign investments in 2006 has mortgage industry watchers concerned that if China buys fewer U.S. Treasury securities this year, it may drive interest rates higher and pour more cold water on the real estate market.
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Home mortgage rates are closely tied to Treasury rates and any rise in the cost of borrowing could further slow home sales. A series of increases in the overnight bank lending rate by the Federal Reserve since 2004 has already made adjustable-rate mortgages more pricey. Further rises in the yield of 10-year Treasury notes, which lenders use as a benchmark for rates they charge for 15- and 30-year fixed-rate mortgages, could make those mortgages more expensive as well.
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While mortgage rates today are up from their record lows, they are still much lower than the double digit rates seen in the 1980s. But there are signs that higher borrowing costs already are weighing on sales.

The National Association of Realtors said last week its measure of sales contracts signed in November dropped 2.5 percent, a third consecutive decline. On Tuesday, The association said it expects the 30-year fixed-rate mortgage to rise gradually to 6.7 percent during the second half of the year.

Shanghai homeowners are concerned about their own real estate market. Is this a sign of things to come in the U.S.?

A Home Boom Busts

American homeowners wondering what follows a housing bubble can look to China's largest city.

Once one of the hottest markets in the world, sales of homes have virtually halted in some areas of Shanghai, prompting developers to slash prices and real estate brokerages to shutter thousands of offices.

For the first time, homeowners here are learning what it means to have an upside-down mortgage — when the value of a home falls below the amount of debt on the property. Recent home buyers are suing to get their money back. Banks are fretting about a wave of default loans.

"The entire industry is scaling back," said Mu Wijie, a regional manager at Century 21 China, who estimated that 3,000 brokerage offices had closed since spring. Real estate agents, whose phones wouldn't stop ringing a year ago, say their incomes have plunged by two-thirds.
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Shanghai's housing bust comes after a doubling of prices in the previous three years, a run-up fueled by massive speculation. With China's economy booming and Shanghai at the center of worldwide attention, investors from Hong Kong, Taiwan and elsewhere were buying as fast as buildings were going up. At least 30% to 40% of homes sold were bought by speculators, says Zhang Zhijie, a real estate analyst at Soufun.com Academy, a research group in Shanghai.